Outsourcing: Russian Federation overview
A Q&A guide to outsourcing in the Russian Federation.
This Q&A guide gives a high-level overview of legal and regulatory requirements on different types of outsourcing; commonly used legal structures; procurement processes; and formalities required for transferring or leasing assets. The article also contains a guide to transferring employees; structuring employee arrangements (including any notice, information and consultation obligations); and calculating redundancy pay. It also covers data protection issues; customer remedies and protections; and the tax issues arising on an outsourcing.
To compare answers across multiple jurisdictions, visit the Outsourcing Country Q&A tool. This article is part of the multi-jurisdictional guide to outsourcing. For a full list of contents, please visit www.practicallaw.com/outsourcing-mjg.
Regulation and requirements
The legal framework for outsourcing is still developing in the Russian Federation (RF) (Russia). The law neither specifically defines outsourcing (with an exception in relation to financial services, see Question 2) nor regulates it directly. However, the outsourcing market is growing rapidly and some kinds of outsourcing, such as IT outsourcing, business process outsourcing (BPO) and human resources (HR) outsourcing, are very popular in practice.
Generally, outsourcing of financial services in areas such as investments, insurance, securities and so on must comply with the civil law rules regarding provision of services and any applicable specific legislation. In addition, the letters of the Central Bank of Russia (CBR) provide some guidance on outsourcing. However, the CBR is the statutory regulator for credit companies (that is, banks and non-banking credit companies) and therefore the letters are intended solely for credit companies. Unlike the CBR instructions and regulations, the letters are quite general recommendations.
Banking operations can only be outsourced to another bank, not a common supplier, due to strict licensing requirements. Treasury outsourcing, particularly cash pooling, is subject to special currency regulations. Due to restrictions on hard currency circulation, cash often cannot be actually accumulated in one account but must be pooled from a number of individual accounts. (Other functions in treasury can be outsourced without facing regulatory difficulties.) Banks can outsource some back-office functions such as accounting, IT support and internal audit to any appropriate supplier, as these operations do not require a licence.
The CBR recommends that banks consider the following matters when deciding on the applicability of outsourcing:
Factors of operational risk arising from outsourcing.
Control over those operational risks.
The importance of outsourced functions to the bank and a risk of dependence on the supplier.
Supervision over the quality of services and legal compliance.
Contract terms including a proper assignment of rights and provisions regarding the bank and supplier's obligations.
Internal regulations for procedures on mitigating risks arising from outsourcing, including the risk of refusal of services.
In addition, the CBR provides some guidance in relation to internal audit outsourcing (with reference to the Basel Committee on Banking Supervision):
Due diligence of the supplier is recommended.
Long-term contracts can be beneficial.
Contract terms should contain a requirement for the bank management to give their preliminary consent to the supplier's audit plan and risks analysis, as well as enable them to access the supplier's records, working plans and working tables.
In relation to BPOs such as accounting, tax compliance and payroll, the regulations for preserving information for accounting and tax purposes apply.
Accounting records must be retained for at least five years, and tax records for at least four years. Companies must permanently keep statutory documents such as:
Any changes to the Charter.
Annual financial statements and tax declarations.
Certificate of incorporation.
The following documents must be retained as follows:
Quarterly financial statements and tax declarations for at least five years.
Monthly financial statements and tax declarations for one year.
Directors' personal files (permanently).
Files of other employees for 75 years.
Personal data protection regulations are also relevant to BPOs (see Question 18).
Representative offices of foreign companies often outsource accounting and tax compliance functions, and can choose between Russian law and their national law in relation to the accounting regulations (subject to their national law not conflicting with International Financial and Reporting Standards (IFRS)). However, the selection is not available in relation to tax compliance. Therefore, many companies choose to apply Russian law both for accounting and tax purposes and then request transformation of reporting to their national law or IFRS. Under an outsourcing contract, the legally defined function of the chief accountant is transferred to the outsourcing provider. This can have legal consequences for the provider under the Administrative, Tax, Customs and Criminal Codes.
Foreign representative offices can, in theory, store the accounting and tax records abroad. However, companies must be able to present the records (in Russian) to the tax authorities within a few days, so this option is not advised. The outsourcing of the accounting function is regulated by the law on accounting, under which there are four ways to organise the accounting.
There are no specific regulations regarding IT outsourcing. However, if the outsourcing involves transferring or sublicensing software licences, intellectual property (IP) legislation applies. Software is protected by copyright. Copyright itself is not subject to any registration but arises solely from developing the software. To ensure the software is protected, it must be registered with the Russian Patent and Trademark Office.
New data protection regulations are also relevant. From January 2010, all organisations must comply with the new Law on Personal Data (No. 152-FZ) (Law on PD). This law was adopted in accordance with the Convention for the Protection of Individuals with regard to Automatic Processing of Personal Data (ETS 108). The Law on PD obliges organisations to ensure respect for individuals' fundamental human rights in relation to processing personal data.
There are no specific regulations that are relevant to telecommunications outsourcing (for example, outsourcing customer support services to a call centre). However, if a telecommunications operator outsources operation of part of its network, the Law on Electronic Communications (No. 126-FZ), which regulates telecommunications operators, can apply.
Public procurement rules are contained in the:
RF Civil Code (Civil Code).
RF Budgetary Code (Labour Code).
Law on contracts for state needs (No. 94-FZ in particular).
Works or services intended for the Russian state or public and financed by state, must generally be performed on the basis of a state contract. The only exception is contracts for a small amount, currently up to RUB100,000, which can be charged every three months.
A state contract is placed through an open tender, an auction or after requesting quotations from several suppliers. Some works and services are exempt from this procedure, for example, state order of military applications, development of narcologic and psycho-tropical medicine and financial support of cinematography. The awarding authorities must advertise the contract on the official internet page www.zakupki.gov.ru (currently only in Russian) and follow special rules and procedures.
There are no other relevant additional regulations.
There are no regulatory notifications or approval requirements.
As part of BPO, the following requirements must be met:
Official assignment of Chief Accountant (CA) duties. This is formalised by an issue of order, under which the outsourcing company acts as the CA of the customer carrying the responsibility for its financial and tax accounting. As a CA, the outsourcing company is responsible for the quality of the services, in particular for the correct and timely preparation and submission of documents and/or reports to:
the Inspector of the Federal Tax Service;
non-budgetary funds; and
state statistics bodies.
Power of attorney. This is needed for representation in tax and other authorities.
Preparation of documents. For non-fulfilment or improper fulfilment of the obligations under order and contractual agreement with the customer, the supplier bears responsibility in accordance with legislation and conditions of agreement. The supplier bears the responsibility if documents or reports are incorrectly prepared or reported, and undertakes to compensate the customer for losses, including penalties, fees and arrears on tax payments.
Bank card participation. This is necessary if the customer engages the outsourcing company to authorise the customer's banking operations as the CA. This function is optional and depends on the customer's particular needs. The technical preparation of payment orders and processing of the banking operations can be performed by an outsourcing company through limited access, and without authorisation rights.
Service or works contract
Description of structure. The most common legal structure in outsourcing is a contract for services or works provided by a third party without acquiring or leasing assets or employees.
Generally, two types of contracts are used:
A service contract, which solely implies the delivery of the contracted scope of work. This contract favours the supplier.
A works contract, which implies the delivery of a certain agreed result. This contract favours the customer.
The service contract structure is often used on the outsourcing of IT, cleaning, recruiting, marketing, advertisement, security, legal or accounting services.
In relation to accounting services, the customer is liable for the supplier's mistakes, as the customer is generally responsible for its financial statements. Therefore, additional warranties in relation to the supplier of outsourced accounting services are very important for the customer.
Advantages and disadvantages. An advantage of the service contract is the flexibility that it provides the parties to arrange their contractual relationship. The law generally affords the parties with a high degree of autonomy in formulating their rights and obligations. The parties have to agree on the subject matter for the service contract to be concluded. The service contract can also be cancelled by the customer unilaterally in a simplified manner. The customer only needs to reimburse the supplier for the actual expenditure. There is no compensation for loss provided by the law. If the contract is cancelled by the supplier, it must indemnify the customer for the incurred losses.
The works contract is regulated in more detail. The contact contains more conditions on which the parties must agree for the contract to come into effect. However, once the works contact is concluded, it is more difficult for any of the parties to unilaterally cancel it. The customer can only cancel after compensating the supplier proportionately to the work already performed. In addition, the customer must indemnify the supplier for the incurred damages. The law does not provide for the right of the supplier to cancel the contract unilaterally.
Staff leasing, temporary staffing, outstaffing
Description of structure. HR outsourcing has become a widespread practice in view of the ever-growing demand for highly skilled professional staff. The supplier's employees work either at the customer's or supplier's place of business, retaining existing current employment relations with the supplier. The following structures are most common:
Staff leasing, that is a secondment of the supplier's employees to the customer.
Temporary staffing services, which is a secondment of the supplier's employees to the customer for a short-term period.
Outstaffing, that is the customer's employees are transferred to the supplier's payroll, with the following secondment of the employees back to the customer.
Outsourcing of the whole departments of the customer's company, with full administration of work schedules, structure and job efficiency.
Advantages and disadvantages. HR outsourcing is an attractive way to minimise company HR costs and transfer this sector of the business activities to the experts.
The activities outsourced include, for example:
Preparing documents for new hire.
Preparing HR documents for amendment of employment contracts (for example, by way of a transfer, salary rate changes, changes in working hours and other provisions).
Preparing dismissal documents.
Preparing HR documents for leaves (annual paid leave, additional leave).
Compiling of timesheets (in accordance with T-13 Form, used to evaluate employee days worked and absent in the reporting period) for a five-day working week with Saturday and Sunday as days off (once during the working period).
Compiling of timesheets (in accordance with T-13 Form) for a working schedule other than a five-day working week (once during the working period).
Providing the customer with personnel data in the standard data output form from an information system (twice during the working period).
The disadvantage of these legal structures is the absence of any labour law regulations regarding outsourcing of personnel, and resulting tax and legal risks under current legislation. Tax authorities are suspicious of personnel outsourcing as outsourcing is sometimes used for tax optimisation. There is a risk that outsourcing can qualify as a tax offence. Courts have supported this position in relation to personnel outsourcing on two occasions:
Rulings of the Presidium of the Supreme Commercial Court of the Russian Federation No. 12418/08 of 25 February 2009.
Rulings of the Presidium of the Supreme Commercial Court of the Russian Federation No. 17643/08 of 28 April 2009.
Trust management agreement
Description of structure. A trust management agreement (or trust of estate contract) under Chapter 53 of the Civil Code can be particularly useful for the outsourcing of property management or production of goods functions. Under the trust management agreement one party (settlor of trust) transfers the estate on trust to the other party (trust administrator) for a definite period. The trust administrator undertakes to administer the estate in the interests of the settlor or the person indicated by him (beneficiary). Notwithstanding the transfer of the estate in trust, the settlor remains the only owner of the estate. In addition, estate in trust forms a legally separated estate from both the trust settlor and the administrator. The trust administrator must separately account for it in the balance sheet. The debts and obligations in connection with the trust estate must be repaid at the estate's expense.
The objects of trust can include:
Enterprises and other property complexes, particularly facilities relating to real estate.
Rights certified by non-documentary securities.
Money cannot usually be an independent object of a trust.
Advantages and disadvantages. The advantages of a trust management agreement include:
Confidentiality of information about beneficiaries.
Convenient form for taxation optimisation.
Safeguarding of assets (in an irrevocable trust the property cannot be obtained by the lenders and remains in the beneficiary’s control).
The disadvantages include loss of control of assets, creating the danger that the property will not be used in the manner intended by the trust founder, or that the trust manager will act disloyally towards the founder's property.
Description of structure. A number of other common legal structures and contracts can be used in an outsourcing such as establishing a subsidiary or a joint venture. The assets and/or rights can be transferred to the supplier under a leasing agreement, sale or licensing.
Advantages and disadvantages. These structures have no specific advantages or disadvantages when used in an outsourcing, compared to using them in other fields.
The first step in choosing a supplier is defining the functions to be outsourced. Estimating the scope of those functions is very important, and should be performed by someone with at least a working knowledge of the specifics of the functions. An accurate estimate can reduce the range of potential suppliers considerably, as it can demonstrate, for example, that those functions either:
Are highly specific, meaning that a highly specialised outsourcing company should be hired.
Have an extremely broad scope, in which case it would be preferable to choose a supplier with equally broad fields of expertise.
The importance of this step cannot be overstated as having only a vague idea of the services that the outsourcing company will perform when selecting one results, mostly, in tensions between the customer and supplier, and long-lasting mutual dissatisfaction. A relatively new outsourcing market and development of a service culture in Russia makes the estimate even more essential.
After clearly defining the scope of outsourced functions, the range of the suppliers must be selected. Various ratings, surveys and rankings carried out by independent market researchers (which are currently abundant in Russia), as well as other open sources of information are very helpful. However, considering the peculiarities of the relatively young Russian market, these sources are reliable only to a certain extent, which means that word-of-mouth is perhaps more important than in many developed economies. According to surveys, most businessmen think there is nothing more reliable than a personal recommendation from a trustworthy source.
After prospective suppliers are outlined, the customer often performs a brief due diligence of those. This procedure usually involves an analysis of the supplier's (among other things):
Past and current projects.
The criteria for the selection of a supplier must be determined in advance, although they are also subject to review and adjustment after a direct contact with the potential suppliers.
Request for proposal
The companies considered suitable and shortlisted for further consideration are given a request for proposal (RFP) with a brief outline of the functions to be outsourced and other information the customer considers important.
Invitation to tender
Alternatively, the customer can hold a tender, in which case the RFP looks more like an invitation to tender. However, tender is more suitable where the outsourced function is relatively basic. For example, a tender for highly specialised legal services is not recommended.
The next step is creating a shortlist of suppliers and direct negotiation with them. The customer can choose only one or two potential suppliers at this point. This reduces transactional costs but also reduces competition. The initial draft contract is normally prepared by the supplier who usually has a number of model contracts. However, the customer can customise the contract, particularly if its market standing and the remuneration it is prepared to offer puts it in a strong bargaining position.
There are no other relevant processes. However, typically the most successful companies are those offering an extensive range of specialised services.
Transferring or leasing assets
Formalities for transfer
Generally, transfer of title to immovable property must be in writing and requires registration. However, in relation to outsourcing, transfer of title to immovable property is not necessarily required. If the supplier needs to use the customer's immovable property during outsourcing, the customer can instead lease or otherwise transfer the asset to the supplier. A trust management agreement is one of the possible methods (see also Question 5, Trust management agreement). A trust management agreement regarding immovable property must be in writing. The transfer of immovable property into trust management must be registered in the Unified State Register of Rights to and Transactions with Immovable Property.
IP rights and licences
If IP rights (such as patents, utility models, industrial designs and trade marks) are to be used during outsourcing, the transfer must be registered with the Russian Patent and Trademark Office (www.rupto.ru). Transfers of IP licences must also be registered. Transferring or licensing IP rights without registration is void.
The transfer of movable property must be in writing. Some assets which are subject to specific regulation (for example, cars or trucks) require state registration. However, registration can be avoided by leasing out or transferring the property to the supplier.
Claims and liabilities under the contracts can be transferred with the consent of all three parties (that is, customer, supplier and a third party). The contract for the transfer must follow the same formalities as the key contract, for example, if the state registration of the key contract was required, the contract of transfer must also be registered.
Formalities for leasing or licensing
Lease agreements must be in writing. If the term of immovable property lease is one year or more, the lease agreement must be registered in the Unified State Register of Rights to and Transactions with Immovable Property.
IP rights and licences
Any use of IP rights in relation to patents, utility models, industrial designs and trade marks, including their licence, must be registered with the Russian Patent and Trademark Office. The licence agreement must be in writing.
Lease agreements that relate to movable property must be in writing. The owner must physically transfer possession of the property.
Key contracts cannot be leased or licensed under Russian law.
In an outsourcing agreement, employees are not transferred by operation of law. The subject matter of an agreement regarding the provision of staff, is the services provided by the staff of the outsourcing provider. The outsourcing supplier's employees typically work at the customer's or supplier's place of business, retaining their existing employment with the supplier.
However, an outstaffing structure is different. The employees are transferred from the customer's staff list to the supplier's payroll.
Each transfer of employees infers a new employment contract for an employee. The contract with the customer (as the employer) must be terminated. The outstanding salary (including the amount of compensation for the remaining or unused vacation days, for the period of employment, and other reimbursements) should be paid to the employee on his last working day. The employee can apply his transfer to the other employer (to the supplier) and the supplier accepts his position as the new employer as part of the transfer. This way is favourable for the employees, because they will be certain sure that the new employer (supplier) will employ them.
The following must be considered on the termination of employment contracts regarding a change of supplier:
The employee's written consent to the transfer must be secured, expressed either unilaterally by the employee or as an agreement between the employer and the employee.
The new supplier's written consent to employ the staff is required. Consent can be expressed either in the exchange of formal letters, or alternatively as an agreement between the two suppliers.
The employees are then seconded back to the customer. This part of the legal relationship involves certain ambiguity and risk, as outsourcing relations are not covered by Russian civil law. Most of these risks arise if the outstaffing agreement is declared null and void under the Civil Code. This can happen, for example, if either:
The parties define the subject matter of the agreement incorrectly, treating individuals as transactional objects, which is not possible under Russian law.
The supplier's employees are recognised as the customer's employees for tax purposes, which also raises financial consequences for both the customer and the supplier.
After the 1 January 2016, outstaffing will be prohibited by law. It will only be possible to organise the outstaffing for special agencies and between affiliated structures or business unities.
Change of supplier
The change of supplier does not transfer employees to the new supplier by operation of law. The transfer requires the termination of the employees' employment contracts, and payment of all outstanding payments. Employees are considered to be transferred after completing the special procedure of transfer, that is, after termination of their employment contracts with the supplier and entering into an employment contract with the customer. In all other cases, a transfer is not considered appropriate.
If the outsourcing terminates and the customer transfers the services back in-house, the employees are not transferred from the supplier to the customer by operation of law. It is a transfer of employees (see above).
For more information on transferring employees on an outsourcing, including structuring employee arrangements (including any notice, information and consultation obligations) and calculating redundancy pay, see Transferring employees on an outsourcing in Russian Federation: overview.
Data protection and secrecy
All organisations employing staff or processing the personal data (PD) of individuals (that is, personnel, customers and business counterparties) are subject to the law on PD. The parties to the outsourcing contract must comply with the law on PD irrespective of any contractual provisions.
The requirements concerning the protection of PD must be observed in the contract documentation between a PD controller and its counterparties. The requirements include that the PD controller must:
Include a confidentiality clause in its contracts with third parties obliging third parties to ensure confidential treatment of PD.
Obtain consent from individuals or organisations whose PD is to be transferred to third parties under contractual obligations. Where consent cannot be obtained, the PD controller has to include provisions in the contract that oblige third parties to obtain the consent directly from the individuals.
Be liable to PD subjects for failure to ensure compliance with the requirements of the law on PD by the third parties, to whom PD was transferred under contractual obligations between the third parties and the PD controller.
Liability of a supplier for breach of data protection requirements arising out of a contract are handled according to the general principles of civil law. A counterparty affected by the breach of requirements related to PD protection is entitled to claim damages or resort to other remedies available under the contract (for example, contractual penalties) or the law. There are no special caps provided for by the law for such claims.
The Law on PD provides that personal data can be transferred to countries party to the Convention for the Protection of Individuals with regard to Automatic Processing of Personal Data (Convention 1981), or to other foreign countries that ensure an adequate protection of personal data. However, the transfer may be forbidden or limited with a view to protecting the basic constitutional values of Russia, including moral and health rights, the legitimate interests of its citizens, and ensuring the defence of the country and safety of the state.
Foreign states must comply with the provisions of Convention 1981 for a PD to be transferred from Russia to the foreign state. Before transferring PD to a foreign country, a PD controller must check that the foreign country ensures adequate protection of the rights of PD subjects.
Countries that are not party to Convention 1981 may be included in the list of the foreign countries that provide adequate protection of PD, provided the countries comply with the provisions of Convention 1981.
Cross-border transfer of PD to foreign countries that do not provide adequate protection of the rights of PD subjects can be carried out only in limited cases directly provided for by the law on PD:
Where there is written consent of a PD subject for the transfer.
Where it is allowed by international treaties of the Russia.
In cases directly provided by federal laws.
Where it is required for the fulfilment of a contract with a PD subject.
The Russian Federation has ratified Convention 1981. It is therefore required that the security standards provided in Convention 1981 are implemented and complied with by the parties processing PD.
According to the latest amendments to the law on PD, as of 1 September 2015, the PD related to the citizens of Russia may be collected, recorded, saved, amended or otherwise processed by the PD controllers only on the servers located in the territory of Russia. It is not currently clear, whether the duplication of data related to Russian citizens outside of Russia (after the initial collection and processing of data took place on servers in Russia) would be allowed according to the latest amendments to the law on PD.
Data protection and data security
General requirements. The law on PD imposes heavy requirements on organisations with regard to PD security. The PD controllers who process PD are obliged:
To notify data protection authorities of the intent to process personal data.
To develop internal regulations on PD processing standards and rules.
To implement a PD protection system that complies with the statutory requirements for technical security of premises.
A company implementing a PD protection system can rely on its in-house resources or seek external professional advice. The most efficient approach is a co-sourcing where the implementing company invites an external provider (an information security integrator company) and establishes a specialised in-house implementation team. This approach involves an additional expense of contracting an external company, but can be more appropriate as the supplier's know-how makes the whole process more efficient.
Sanctions for non-compliance. The sanctions for non-compliance with provisions of the law on PD can involve civil, administrative and criminal liability.
Civil liability includes a claim for pecuniary and moral damages. Administrative liability includes a fine to be levied on officials or legal persons for failure to comply with a required order of PD processing. Criminal liability may be imposed for illegal collecting or disseminating of PD related to an individual's private life. The criminal sanctions can include a fine, compulsory labour, or imprisonment.
Security requirements. The banking secrecy is guaranteed by the Law on Banks and Banking Activity (Law on Banks). All credit organisations (both banks and non-banking financial organisations) and their employees are required to keep banking secrecy in respect of their clients and banking operations performed by them. The Law on Banks provides a limited number of situations where credit organisations can disclose banking secrets, in addition to a limited number of persons (courts, law enforcement authorities, tax authorities and other authorised persons) who can request disclosure of banking secrets.
International standards. There is a federal law "On combating legalization (laundering) of criminal proceeds and financing of terrorisms" that provides the general framework for international co-operation in this area. Russia actively co-operates with Financial Action Task Force (FATF) and has established a special body to combat money laundering and prevent financing of terrorism (Federal Service on Financial Monitoring).
Sanctions for non-compliance. Legislation provides for the following sanctions for breach of confidentiality of banking secrets:
Criminal liability. Illegal disclosure or use of banking secrets without the owner's consent by the person to whom it was entrusted is punishable by a penalty with deprivation of the right to occupy certain positions or imprisonment for up to three years.
Civil liability. If banks disclose banking secrets, the client can claim damages for the losses caused.
However, considering the high number of individuals and organisations that have a legal right to obtain banking secrets information, the civil and criminal sanctions offer no great protection for bank account owners.
Confidentiality of customer data
The general regime of PD protection provided by the law on PD also applies to the confidentiality requirements of customer data (see above, Data protection and data security). The legislation on the protection of customers' rights and other legislation (CC, the law on banks and banking activity) also apply.
Service specification and levels
The services specification is usually drawn up by the party drafting the entire contract, the supplier in most cases. Naturally, these clauses are drawn up in close co-operation with the customer. However, service specifications are often drawn up vaguely in the contract or in any of its attachments. The parties merely stipulate that the supplier will render services in a certain field of expertise based on the customer's individual orders.
Although many contracts do not include any service levels and service credit clauses and provide for nothing more than general obligations to render services of due quality in good faith, it is strongly advisable to define the quality expected from the supplier. This is not always possible, for example, with outsourcing legal functions, as:
The successful performance greatly depends on a number of external factors.
It is often not possible to define an expected result.
However, with most other functions, the customers want to achieve a specific result and the provisions regarding service levels are then helpful.
The service credits usually provide that in the case of the supplier's failure, either entire or partial, the fees paid to the supplier are reduced. These clauses are compensatory, rather than punitive. The service credits must be proportionate to the damage sustained by the customer. Their precise definition in the contract is nearly impossible, so they are usually decided on a case-by-case basis.
Flexibility in volumes purchased
Russian law does not set specific requirements with regard to the adjustment of the volumes that customers purchase. Usually these issues are addressed in the contract between the parties (if an increase or decrease in volumes is anticipated). However, the law does not oblige the parties to expressly negotiate provisions on the adjustment of volumes purchased.
If the customer's needs change so that it requires higher or lower volumes from the supplier, this would normally be addressed by making a request under the change control provisions of the contract. The extent to which the supplier can be obliged to accept the change will depend on the terms of the contract (provided the change control procedure agreed between the parties).
Typically, most change control provisions only permit material changes where required by law or when both parties can reach agreement. It follows that (in the absence of any provisions specifically addressing the issues) the level of flexibility in practice will be heavily dependent on the ability and willingness of the supplier to accommodate any changes requested by the customer.
Charging methods and key terms
The fixed price method is commonly used, particularly for a relatively homogeneous work lasting a long time (usually several years), for example, accounting and reporting. This method implies defining, in advance, the minimum monthly volume of the services to be provided so that fixed price is viable. The fixed price method gives certainty to both parties to the outsourcing contract.
Pay as you go
Sometimes it is necessary to provide for possible changes in the volume of the services provided during an outsourcing agreement. The changes in the volume may result from:
Seasonality of the customer's operations.
Changing legal requirements.
These factors and resulting additional work can be dealt with by using flexible rates, depending, for example, on the number of documents, payment transactions or employees on the payroll.
Hourly rates are appropriate for some additional or tailor-made services not directly included in the subject of the outsourcing contract. In respect of, for example, accountancy and reporting, this can involve consultancy regarding internal control system development, accounting procedures and international reporting or reporting automation. The most rational approach is to set hourly rates for professionals according to their qualification. An hourly rate usually includes the cost of providing a service, as well as a profit margin.
The customer pays the supplier an agreed profit margin on the actual cost of providing the services. A foreign investor may find it difficult to understand the Russian supplier's cost structure and accounting system. Therefore, additional provisions are necessary, to ensure that both parties to the outsourcing contract agree to, and understand, the methods of calculating the costs.
For many outsourcing contracts, a combination of charging methods is an optimal method of pricing. This ensures sufficient flexibility for both parties to the contract.
In addition to charging a good price for the outsourced services, it is essential to ensure the profitability of the rendered services for the longer term. One of the factors influencing the profitability is the amount of time spent by the supplier. Therefore, it is vital to ensure flexibility of pricing (see Question 22) and to control the time spent by the supplier. Further macroeconomic factors such as exchange rates and inflation must be considered. Their impact can be dealt with by including the necessary clauses in the contract. For example, the EUR exchange rate can be determined on the particular agreed level, with a recalculation and revision at the end of a year.
It is particularly important to consider inflation. It can be useful to base the fee on the inflation index or another index (such as, wage index) to avoid the negative impact of inflation for the supplier. As outsourcing is labour driven, the labour market must be considered. Due to market changes in availability of highly qualified specialists, labour market conditions can give companies varying degrees of opportunities to establish in-source accounting and reporting functions.
Remuneration can also be affected by an agreed level of an outsourcing company’s responsibility for possible professional errors.
Through the course of time the volume of a customer’s business transactions or business model may change. However, the legislation and the general economic situation are not immutable. For example, transfer pricing which is relatively new in Russia. The relations with the outsourcing company and terms of outsourcing agreement have to be flexible or necessary proposals, and adjustments must be initiated by the parties in good time.
Customer remedies and protections
Generally, the discharge of obligations can be secured by a forfeit penalty, pledge, retention of the debtor's property, surety, bank guarantee and advance payments.
When the supplier fails to perform its obligations, the customer can demand from the supplier the following, at his discretion:
Gratuitous removal of defects within the reasonable period.
Adequate reduction of the fee for the works or services.
Reimbursement of expenses incurred during the elimination of defects, when the customer's right to remove them is provided for by the contract.
Termination of the contract, if the breach is material.
However, there is usually no provision for compensation above the fees already paid. Currently, this can be described as a general rule in most segments of services.
Reporting requirements, information security and property security are integral provisions of an outsourcing contract. The customer sometimes demands from the supplier a guarantee in the form of liability insurance. In relation to accounting services, the customer often has statutory audit obligations. Alternatively, these rights can be included in the outsourcing contract. In addition, specific provision for termination in specified circumstances, for example on insolvency, can be included in the outsourcing contract. Financial penalties are also a popular form of customer protection, for example, for late delivery of works or services.
Warranties and indemnities
Russian law does not have the concept of warranties or indemnities. However, the contract documentation can be drafted in a foreign-law style including warranties and indemnities. The warranties can still be considered as mere contractual obligations, giving rise, on their breach, to a claim for damages or to termination of an agreement (if the breach is material). Indemnities are also mostly treated as contractual obligations, leading to a claim for damages if they are breached.
Obligations must generally be duly performed in accordance with the contract terms and legal requirements. If no terms or requirements apply, obligations should be performed in accordance with business practice. Therefore, the parties can specify particular requirements regarding fitness for purpose and quality of service, or limit their responsibility.
Since the liability is governed by Russian civil law, the parties are free to stipulate any kind of agreements regarding liability as long as the agreements do not contradict mandatory Russian civil law. For example, the parties can, under certain circumstances, contractually limit the damages by stating that damages will only include the direct actual damage and therefore exclude the indemnification for lost profits. It is also possible to exclude suppliers' liability for slight negligence. In general, these conditions favour the supplier, as its liability is limited. Customer-supplier relationships for employee arrangements are not governed by Russian labour law. Therefore, suppliers' liability can be restricted, that is, by way of restriction of the liability amount.
Term and notice period
Russian law does not impose any maximum or minimum term on contracts. Contracts are often concluded "until the fulfilment of all parties' obligations". Where appropriate, a contract should specify a term to avoid uncertainty. It can also provide for an automatic renewal on an annual basis. Due to the business nature of the outsourcing, the contract should be concluded for a longer term.
Termination and termination consequences
Events justifying termination
On the demand of one of the parties, the contract can be terminated (by the court) if there has been a fundamental breach by the other party. A fundamental breach results in losses for the other party that deprive it, to a considerable extent, of what it could have expected when concluding the contract. The terminating party is still entitled to claim damages.
Essential change of circumstances
An essential change of circumstances is also a termination ground, subject to the contrary provisions in the contract, whether express or implied. The change of circumstances must be recognised as essential, that is, the circumstances have changed to such an extent that if the parties could have envisaged it, the contract either:
Would not have been concluded by them.
Would have been concluded on essentially different terms.
If the court terminates the contract on grounds of the essentially changed circumstances, it will define the consequences of the contract termination, attempting to justly distribute the expenses related to the contract execution between the parties.
Bankruptcy of the outsourcing customer is deemed a valid ground for termination. In certain situations the law on bankruptcy obligates the insolvent party, that is unable to honour its liabilities, to independently file an application in writing seeking to be acknowledged bankrupt. The court can also receive a third party application (from, for example, a creditor or public authorities) seeking bankruptcy status for a certain company.
Filing of an application seeking bankruptcy status is not a valid termination ground in itself. However, a company having financial problems means that such a company is unable to honour its liabilities. Where a claim is in existence (for example, regarding payment of debt), the outsourcing company can apply to court seeking to include the respective debt in the creditor claims register of the company that is in the process of being acknowledged bankrupt. The claim to recover the debt (in the event it is not connected with operating activities) will be satisfied on completion of the bankruptcy procedure.
Generally, the customer can terminate the contract, provided the supplier's incurred expenses are paid. The supplier can also terminate the contract provided the customer's losses are fully reimbursed.
The parties are free to agree on additional termination terms. For example, the customer can include rights to terminate the contract if:
The contract price exceeds a fixed amount.
The contract is not performed with due care and diligence.
There is change of control, particularly if the supplier becomes controlled by a third party that is a competitor or potential competitor of the customer.
Any remedies that do not violate the law can be included in the text of the contract as agreed between the parties.
If the international or national ranking of trustworthiness has been assigned to the buyer and the buyer's trustworthiness according to this ranking has become worse, the parties can provide for the termination of the contract or early payment for the delivered goods by the buyer.
The parties can provide for the seller's reservation of the title to the goods until the buyer makes full payment (or pays a particular percentage of the total cost of the goods).
The parties can provide for termination of the contract in case of any changes in the composition of shareholders/owners of one of the parties.
The parties to the contract must be entitled to extend the range of cases in which the contract can be terminated in a judicial proceeding. This is by indicating that in nearly all cases the contract can only be terminated in a judicial proceeding, or by extending the range of cases in which the contract can be terminated without recourse to legal action (by indicating that the contract can be terminated unilaterally on occurrence of particular circumstances).
IP rights and know-how post-termination
This depends on the terms regarding know-how agreed by the parties in the outsourcing contract. In some cases the supplier does not object to the customer using its know-how. More often the parties agree on a time period, when the customer is entitled to use the supplier's know-how, after which the use of this know-how can constitute a breach of confidentiality.
The customer often requires the supplier's know-how to in-source the works or services. The supplier can offer his know-how for an extra charge on the basis of a service contract. In addition, the supplier can train the customer's employees in the supplier's area of competence, which usually is also based on an agreement to render services. Finally, the supplier can act as a consultant for the customer in its area of expertise.
Liability, exclusions and caps
The contracting parties can agree to limit the debtor's liability unless the limitation is prohibited by the law. More specifically, it is not permitted to limit the liability under a M&A agreement or under any contract where the creditor is a consumer who is an individual in situations where the law determines the extent of liability for the concerned obligation or breach/non-compliance and the agreement has been concluded prior to the emergence of the circumstances/events giving rise to liability for a breach or improper discharge of obligations. In addition, where a particular contract term or condition is regulated by the applicable accepted practices or principles (because the parties have not agreed otherwise) the contracting parties can agree not to apply the practices or principles, or introduce a different condition. For example, the contracting parties guided by Article 400 of the Russian Civil Code, which allows liability limitations only in respect to particular obligations, can agree to limit their contractual liability for a breach or improper discharge.
The two main methods used in Russia to resolve disputes between legal persons (companies) are pre-court settlement proceedings, and dispute settlement in court.
Pre-court settlement proceedings
Pre-court settlement proceedings are mandatory if the parties have agreed on this approach in the contract from which the claim has arisen. In addition, pre-court settlement proceedings are currently prescribed by law for certain dispute types and in particular for disputes with tax authorities.
Dispute settlement in court
However, in Russia the majority of disputes are settled in state arbitration courts, which consider economic disputes between legal entities, including businesses of self-employed entrepreneurs that do not enjoy the legal entity status in Russia. State arbitration courts resolve disputes according to the Arbitration Procedure Code of the Russian Federation (APC RF).
The APC RF includes a list of the dispute types that are subject to consideration according to a simplified procedure (and resolution by court order). Typically these are disputes with a low amount in dispute, and disputes where claims are supported with sufficient conclusive evidence. As a general rule, such disputes are resolved without summoning the parties to the hearing and within one month of the day on which the court accepted the claim action and started the simplified procedures. A judgment pronounced in simplified proceedings may be appealed within a shorter period of time and with a shorter list of court instances where the appeal can be filed.
Disputes are considered on the basis of a claim action in writing filed with Russian state courts. Typically the court of first instance considers the case for three to six months. To prevent infringements of rights of the parties in dispute, a judgment pronounced by the court of first instance can be challenged in the court of appeal and then in the court of cassation. Judgments pronounced by courts of these three instances can be challenged in revision proceedings in the Supreme Court of the Russian Federation. The Supreme State Arbitration Court of the Russian Federation no longer exists. It was dissolved and integrated into the Supreme Court of the Russian Federation in August 2014. This is why the Supreme Court of the Russian Federation is currently the highest Russian court with the authority to consider economic disputes.
Other dispute methods
Russia is actively attempting to promote other dispute settlement methods, including mediation, through its state and court authorities. If the parties in dispute apply to a mediator (intermediary) and their dispute is settled according to that method, the law grants them a beneficial rate on state duty chargeable in dispute settlement proceedings.
Alternative dispute resolution methods (ADR) including arbitration, intermediation and mediation are used in associations of legal entities (for instance, the Russian Union of Industrialists and Entrepreneurs (RSPP), the European Business Association (EBA), the German-Russian Foreign Trade Chamber (AHK) and others). Submission of disputes for resolution in such associations is voluntary and possible on the force of the concerned company's membership in the association or on conclusion of a respective contract.
Courts of private arbitration exist by many major companies (for example, Gazprom). Such courts have the authority to consider disputes in the event they are the court of arbitration stated in the company's contracts with its counterparties or consumers of its products and services. However, the independence of such courts of private arbitration is currently questioned, in particular by Russian state arbitration courts. Therefore, there are multiple precedents where judgments pronounced by such courts of private arbitration were successfully challenged in Russian state courts.
Transfers of assets to the supplier
The tax consequences of assets' transfers under an outsourcing contract depend on the provisions of the outsourcing contract.
If the contract provides that the supplier must perform works or render services under the outsourcing contract using its own assets, then the transfer of the customer's assets to the supplier would be regarded as gratuitous transfer and be subject to profit tax and VAT. However, if the outsourcing contract provides that the customer must provide the supplier with assets, then the transfer is regarded as non-taxable for VAT and profit tax purposes.
Some special issues might arise if the transfer of assets is treated as an actual or deemed lease. In any case, it is not a widespread practice in Russia to transfer the assets to the outsourcing supplier. However, if special conditions are reached in the outsourcing agreement regarding the lease, then the lease operation is subject to VAT.
Transfers of employees to the supplier
As a general tax rule, a Russian company that employs individuals acts as a tax agent in relation to the employees' personal income tax and is liable for social insurance payments. This obligation arises when a company deals with individuals directly under an employment contract. If the customer provides his own manpower to the supplier, this obligation remains with the customer.
VAT or sales tax
Under the general tax rule, provision of any service in Russia is subject to VAT at 18% (accrued on the cost of service). Provision of some services (for example, research and design (R&D)) can be exempt from taxation. Generally, the customer has the right to deduct or recover VAT amounts in full if the following conditions are met:
The customer has a proper VAT invoice (chet faktura) issued by the supplier.
The services are acquired to carry out operations subject to VAT.
The services are entered into accounting records.
A special rule regarding deduction of VAT exists for companies that perform both VAT-taxable and non-taxable activity.
There is no sales tax in Russia.
Some services that are commonly outsourced can be non-taxable for VAT purposes, if the place of the customer's activity is not considered the territory of the RF (Article 148, RF Tax Code). This is particularly relevant for the following:
Consulting, legal, accounting, engineering, advertising, education services, processing of information services and R&D works.
Transfer of property or assignment of patents, licences, trademarks, copyrights or other similar rights.
Outsourcing of personnel if the personnel work at the customer's place of business activity.
IT services or works regarding developing software and databases, their customisation and modification.
Excise (stamp) duty (the equivalent of sales tax, see above, VAT or sales tax) is generally not applicable to the provision of outsourcing services.
There are no special provisions regarding the taxation of outsourcing services for Russian profit tax purposes. Income and expenses related to outsourcing activities are accounted under general taxation rules.
Expenses on outsourcing services must be properly documented and economically justified to be deducted on outsourcing services, that is, connected to the income generating activities of the taxpayer. Profits received from outsourcing activities are taxed at the basic tax rate of 20%.
There are no other significant tax issues relevant to an outsourcing.
Dr Andreas Knaul
Rödl & Partner
Professional qualifications. Paris, France, 1993; Georgia, US, 1987; Trier, Germany, 1986
Areas of practice. Corporate law and M&A; European and international public business law.
Recent transactions. Many years of experience in provision of services and advisory support to international and Russian companies in diverse industries and operation areas.
Rödl & Partner
Professional qualifications. University diploma in economics, accountant (IHK), international accountant (IHK)
Areas of practice. German, Russian and International Accounting Standards (IAS) and Financial Reporting Standards (IFRS); controlling; financing.
Recent transactions. Many years of experience in provision of services and advisory support to international and Russian companies in diverse industries and operation areas.
Rödl & Partner
Professional qualifications. Attorney-at-law (Germany), Russian MBA
Areas of practice. Labour law; corporate law; restructuring/turn-around law.